Dysfunctional Oil Markets

“HOW do a I tell my customers that polyethylene (PE) price rises are justified by more expensive naphtha, when the market is so weak?” asked an Asia-based sales and marketing executive with a major producer earlier this month.

A second executive with another producer, who has responsibility for the China market, expressed concern in late July that demand was not strong-enough to justify feedstock cost-driven price increases.

Since then the Asian PE market has spluttered along as a result of persistent caution. Prices have edged up and fallen back on converters reluctant to stock-up on resin because of the risk of inventory losses on a sudden correction in crude prices that would drive down naphtha, ethylene and PE.

Margins have been under pressure. For example, the ICIS Weekly Asian PE Margin Report for the week ending 10 August said: “Integrated PE margins in Northeast Asia collapsed this week, plummeting by more than $190/tonne into negative territory for the first time since early March.

“Integrated low-density PE (LDPE) margins are the most negative since ICIS records began in 2000.

“Naphtha prices climbed by a further $52/tonne, raising feedstock costs by 5.8%. Co-product credits fell by 0.7%, predominantly on a $300/tonne fall in butadiene prices.”

In Europe, the impact of volatile naphtha costs on PE prices was summarised by this excellent report from the ICIS European polyolefins editor, Linda Naylor.

“In the week ending Friday 22 June, naphtha traded at a low of $683/tonne (€553/tonne) CIF (cost insurance freight) NWE (northwest Europe), leading to a record drop of €170/tonne in the July ethylene and propylene contracts,” she wrote.

This led to a €170/tonne fall in July PE prices.

Naphtha had bounced back to $931-933/tonne on Wednesday of this week, resulting in a €200/tonne rise in spot PE prices and talk of a three-digit increase in September monomer contract prices.

And yet a distributor said: “I expect (European polyolefins) demand to be down by around 10% in 2012.”

A PE buyer added that this was the widest range of price movements he had ever seen.

So what’s going on?

As we argue in chapter 3 of our e-book, Boom, Gloom & The New Normal, oil markets are dysfunctional. The oil price is out of kilter with actual demand as a result of deregulation that has increased the influence of the speculators.

“Pension funds have become speculators in the markets – based on the conviction that commodities are a new asset class, alongside equities and interest rates. And they have the firepower to sustain the speculation for a long time.”

The chart above, from the Chemicals & Economy blog, shows official weekly US oil and petroleum products inventory figures since 2008.

2008 levels (purple dash) were relatively low, causing prices to be strong until mid-year and the arrival of the financial crisis.

Since then, stocks have never been below the black line. This marks the peak inventory level at the end of 2008.

Supply is no longer a good guide to the direction of oil prices, however. Since the financial crisis, oil prices have been kept high by speculators, with period of extreme volatility.

Polyolefins serve as a good example of the damage that oil markets are causing to the real economy.